Budget Blog Series: Setting the State’s Capital Debt Limit

In formulating the State’s Capital budget each year, the Capital Debt Affordability Committee is required to review the size and condition of State debt on a continuing basis and to submit to the Governor by October 1 an estimate of the total amount of new general obligation debt that may be authorized for the next fiscal year. This year, the Committee recommended a debt limit of $1.075 billion in state general obligation bonds for Fiscal 2014.

This blog is the beginning of a series on the State’s capital budget process, which will look more closely at the criteria used to establish an appropriate debt level for the upcoming fiscal year and issues that may be considered in doing so.

Creation of the Capital Debt Affordability Committee was an outgrowth of two events: the dramatic increase in outstanding debt during the mid-1970s and the release f the department of Fiscal Services’ two-year study in 1974 on the State’s debt picture titled, An Analysis and Evaluation of the State of Maryland’s Long-Term Debt: 1958-1988.

The purpose of CDAC is to recommend the amount of new general obligation debt that may prudently be authorized. CDAC is made up of seven members, six serve ex officio, and one member is appointed by the Governor. Members vote on capital debt recommendations by October 1 of each year based on established criteria, and in consideration of the following:

the amount of additional general obligation debt that will be authorized during the next fiscal year;

capital program needs during the next 5 fiscal years;

projected debt service requirements for the next 10 years;

criteria established or used by recognized bond rating agencies in judging the quality of State bond issues;

on a continuing basis, the size and condition of higher education debt, taking into account any debt issued for academic facilities as part of the committee’s affordability analysis;

other factors relevant to the ability of the State to meet its projected debt service requirements for the next 5 years or relevant to the marketability of State bonds; and,

the effect of new authorizations on each of the factors enumerated above.

CDAC and these other government bodies are all making recommendations, not rules. The recommendations may be disregarded by the Governor or General Assembly — ultimate control over the state budget rests with them.

Debt Affordability Criteria

There are two debt capacity guidelines used by the committee. The criteria were first put into place in 1979, and most recently modified in 2008. The Department of Legislative Services describes the process for changing the criteria, which included expert consultations and public meetings.

As it reviewed the criteria, the committee consulted with rating agencies, investment bankers, and its financial advisor. The Capital Debt Affordability Committee met in public a half dozen times in 2007 and 2008 to discuss debt policy and the criteria. The committee determined that two criteria were no longer appropriate and recommended revising the criteria. . .

The original criteria limited the state debt to 3.2% of the state’s wealth and limited debt service to 8% of state revenues. The state’s wealth is estimated based on personal incomes. The new criteria, which are still in use today, allow the state’s debt to grow to 4% of the state’s wealth, but maintain the 8% limit for debt service payments.

The Governor and the General Assembly are not bound by the recommendation of the Committee, and the guidelines themselves are voluntary. However, the recommendations are loosely adhered to. Last year, CDAC performed the same assessment and found that the State could take up to $1.08 billion in general obligation bonds. During the 2012 session, the Governor’s budget bill allotted $1.1 billion in general obligation bonds and the General Assembly ultimately adopted $1.075 billion.

State Debt Across the Nation

Maryland is not alone in its borrowing; almost all states take debt each year, despite constitutional and statutory provisions requiring balanced budgets. As Governing Magazine reports, there are a variety of state budget laws and they vary in their strictness. In many cases, instead of strictly balancing their budgets each year, states base their borrowing on expected revenues. Governing quotes,

“They compare the expenditures they can expect to the cash they expect to take in,” . . . Byron Schlomach, director of the Center for Economic Prosperity at the Goldwater Institute, explains it. “There are uncertainties in both of those, and the estimates can be adjusted to be realistic or unrealistic.”

The Chicago Tribunequotes Moody’s 2012 report in finding that state debt slowed dramatically in 2011, but was expected to grow slightly in 2012,

“Although both state revenues and personal income generally will grow in the next year, low debt capacity and heightened fiscal management concerns will result in less new borrowing than experienced in the past several years.”

The article cites heightened fiscal management concerns and low debt capacities as reasons for a minimal increase in state debt nationwide. Consideration of Maryland’s debt affordability criteria and fiscal concerns were both raised at Maryland’s recent CDAC hearings.